Gold stocks have suffered
heavy collateral damage following the Federal Reserveís hawkish surprise late
last month, which ignited enormous gold-futures selling by American
speculators. This devastated sector has been battered back down near last
summerís deep secular lows. But these gold-stock price levels are fundamentally
absurd, the product of extreme and irrational sentiment that canít persist for
long.

Todayís gold-stock price
levels are the greatest fundamental disconnect in the entire stock
markets, an epic opportunity for contrarian investors and speculators! The
entire gold-mining industry is trading as if the price of gold, the
overwhelmingly-dominant driver of its profits, was just a small fraction of
prevailing levels. Gold stocks are radically underpriced fundamentally based on
their current and future earnings power.

Stock-market fundamentals are
simple. Investors buy stocks to own fractional stakes in the underlying
companiesí future profits streams. While popular greed and fear bull stock
prices around over the short term, they ultimately mean revert to some
reasonable multiple to their underlying companiesí earnings in the long run.
Profits are the core fundamental foundation of stock prices, universally
throughout all sectors.

In the gold-mining industry,
prevailing gold prices almost exclusively determine profitability. While
gold mines are expensive to operate, their costs are largely fixed in the
planning stages before construction even begins. So higher gold prices
translate directly into higher profits, fundamental strength ultimately
supporting higher stock prices. And the relationship between gold and profits
isnít linear, but highly leveraged.

This is easy to illustrate.
With elite gold minersí operating results still being released for Q3, the
latest full data remains
Q2ís. The leading gold miners of the flagship GDX Gold Miners ETF reported
average cash and all-in sustaining costs of $635 and $895 per ounce that
quarter. The latter number can be rounded up to $900, and represents the
complete costs necessary to sustain current production levels.

When this industry can mine
gold for $900 per ounce, and the metal is trading near $1100, it earns a
$200-per-ounce profit. As gold rallies, those mining costs essentially remain
fixed. This leads to profits that really amplify goldís gains. If gold
merely rallies 10% to $1210 in this example, industry earnings would climb to
$310 per ounce which represents a massive 55% gain. Thatís serious upside
leverage!

Because of this ironclad
innate fundamental relationship between gold prices and profitability in the
gold-mining industry, gold-stock prices have always followed gold. But that key
relationship started breaking down in 2013, and has cascaded to crisis
proportions since. This huge disconnect is readily evident in this first chart,
which compares the benchmark HUI gold-stock index to its earnings-driving gold
price.

Before 2013, gold-stock prices
closely mirrored and amplified the gold price. The higher gold, the greater
prevailing gold-mining profitability, and thus the higher gold-stock price
levels. Gold-stock prices were behaving normally, meandering around righteous
fundamental levels based on reasonable multiples of underlying companiesí
earnings streams. From time to time, sentiment extremes would spawn temporary
deviations.

Sometimes traders became so
enamored with gold stocks that they grew greedy, and bid this sector up to lofty
heights not supported by fundamentals. This last happened in spring 2006, when
the soaring gold stocks were commanding much favor. Other times, traders lapsed
into fear and despair and sold gold stocks to levels far below reasonable ones
based on profits. 2008ís once-in-a-century stock panic is the best example.

But overall, gold-stock prices
tracked gold. Visualize that ultimate fundamental relationship as a
straight line. While excessive greed or fear can temporary pull prices far
above or below that core fundamental line, eventually gold-stock prices always
mean revert back to that reasonable baseline. Until early 2013 that is, when
the markets started radically changing on extreme central-bank money printing
and jawboning.

Thatís when the Fed ramped its
wildly-unprecedented third
quantitative-easing campaign to full steam. QE3 was radically different
than QE1 and QE2 because it was open-ended, with no predetermined size or
end date like its predecessors. Top Fed officials deftly used this to its
advantage, continually implying it was ready to increase the size of QE3ís debt
monetizations if the stock markets suffered any material swoon.

Including gold, which
plummeted in early 2013 on a combination of
extreme gold-futures selling
by American speculators and
epic differential selling of GLD gold-ETF shares by stock investors. The
resulting gold plunge was horrific, especially in the second quarter of 2013
which saw gold plummet 22.8%! That was its biggest quarterly loss in 93
years, which spawned this festering disconnect in gold-stock prices.

Even though gold prices soon
stabilized as that excessive selling inevitably burned itself out, gold-stock
price levels kept falling as investors and speculators fled. This culminated
with major new secular lows in both the metal and its miners in early August
2015. But despite the lower gold prices, gold-stock price levels were so far
from fundamentally reasonable and righteous that they truly entered the realm of
the absurd.

Goldís major secular low came
in early August following an extreme
gold-futures shorting attack
in late July exquisitely executed to manipulate the gold price lower.
Gold slumped to $1084, a major new 5.5-year secular low not seen again until
this week after the Fed put a December rate hike back on the table. With gold
below $1100, the gold-stock prices certainly shouldnít have reflected September
2011ís $1894 peak.

But they should have been
reasonable relative to gold, which was trading at levels last seen in
February 2010. Where were gold stocks trading per the HUI the last time those
recent secular lows were seen? This index averaged 397 that month! Yet in
August 2015 as gold revisited those same levels, the HUI was limping
along near 105. This made no sense at all fundamentally given the elite
gold minersí sub-$900 costs.

The flagship gold-stock index
continued bottom-feeding near 105 in September, when it made a marginal new
secular low just under 105. That happened to be the lowest HUI close since July
2002 a whopping 13.2 years earlier! Where was gold trading the last time
gold-stock price levels were that low? Around $305! And at that point, the
best level gold had yet seen in its young new secular bull was merely $329.

Think about the gross
incongruity of this extreme pricing anomaly. While gold slumped to a
5.5-year low, gold stocks plunged to a 13.2-year low. While gold was around
$1100 and the elite miners were earning $200 per ounce on an
all-in-sustaining-cost basis, the gold stocks were priced as if gold was $800
lower near $300. Absurd is the only word to describe this, these prices are
fundamentally-absurd!

Imagine if Appleís stock was
trading as if it could only sell iPhones for 3/11ths of their actual selling
price. Such an epic fundamental disconnect could only be caused by one thing,
excessive fear. And once that inevitably burned itself out and
dissipated, capital would flood back in to bid this stock back up to reasonable
levels that adequately reflected its profitability. The same thing is
guaranteed to happen in gold stocks.

Like the entire financial
markets, the stock markets in general and gold stocks in particular are
forever cyclical. Prices perpetually oscillate around that
reasonable-valuation-based-on-underlying-earnings line. Excessive greed first
catapults prices far above fundamentally-righteous levels, which is then later
followed by excessive fear that pummels prices far below them. Since neither
extreme can last, cycles exist.

Eventually a point is reached
in these popular-greed-fear sentiment waves when emotional extremes hit absolute
peaks. On the fear side, once prices fall far enough for long enough everyone
susceptible to being frightened into selling low is already out. Only brave
contrarian buyers remain. And with prices hammered to extreme
fundamentally-absurd lows relative to underlying corporate earnings, the upside
is great.

So buyers gradually return to
the radically-undervalued sector like gold stocks today, just a trickle at
first. But since nothing begets buying like rising prices, the gains driven by
the early buying attract in more investors and speculators. They too buy,
amplifying the capital inflows which soon snowball into even broader interest in
the rallying sector. This virtuous circle of buying out of extreme lows
is immensely profitable.

Gold stocks themselves offer a
perfect example. During that incredible once-in-a-lifetime stock panic in late
2008, the gold stocks plummeted 70.6% per the HUI in a matter of months. In the
dark heart of that panic, everyone was utterly convinced this sector was doomed
to spiral lower indefinitely. It was literally left for dead, abandoned in
crushing despair. Sound familiar? Thatís exactly whatís happening today!

Yet out of those very extreme
lows carved in peak fear, a massive new upleg was being born. Buyers
started to return as fear burned itself out. This eventually attracted in so
much capital that the despised gold stocks would more than quadruple over
the next several years! The HUIís incredible 319.0% gains over that span
dwarfed the benchmark S&P 500ís 39.7% rally by over 8x, really multiplying
contrariansí wealth.

Our current extreme cyclical
low in gold stocks is also going to yield to a mighty mean reversion higher to
fundamentally-reasonable gold-stock price levels. The cyclical nature of
gold-stock prices relative to the gold price which drives their profits is even
more apparent through another construct known as the HUI/Gold Ratio. This
simply divides the daily HUI closes by gold closes to quantify their
relationship over time.

The HUI/Gold Ratio distills
down this dominating fundamental relationship between gold-stock prices and the
price of the metal which overwhelmingly drives their profitability. When the
HGR is rising, the gold stocks are rallying faster than gold usually because the
former are returning to favor. When the HGR is falling, gold is rallying faster
than gold stocks usually because the latter are falling out of favor.

Before 2008ís incredible stock
panic, the fundamental link between gold-stock prices and gold worked normally.
For 5 full years leading into the middle of 2008, the last normal years
before that epic panic discontinuity radically altered psychology, the HGR
generally meandered between 0.46x support on the low side to 0.56x resistance on
the high side. Gold-stock prices were cyclical within this secular trend.

The average HGR in those
pre-panic years was 0.511x. In other words, the benchmark HUI gold-stock index
tended to close at levels around 51% of prevailing gold prices. Keep that
normal-condition metric in mind, weíll come back to it. Unfortunately that
normal-year fundamental relationship between the gold miners and the metal they
mine was shattered by the mind-boggling fear maelstrom of 2008ís stock panic.

The gold stocks plummeted far
faster than gold, blasting the HGR down to a 7.5-year low of 0.207x. That was
essentially a secular-bull low, as the gold stocks hadnít traded that cheaply
relative to gold since the very dawn of their mighty 2000s bull market. But in
the dark heart of that stock panic with epic fear being utterly suffocating,
that emotional extreme wasnít sustainable. Peak fear had been reached
with a vengeance.

So as I
predicted at the time
based on this same HGR fundamental analysis, gold stocks soon started to rocket
higher again as capital returned. Over the next several years the HUI more than
quadrupled, with far-higher gains in the smaller fundamentally-superior gold
miners we prefer to own. During the normal years following 2008ís crazy stock
panic, 2009 to 2012, the HGR averaged 0.346x over that secular span.

Remember that number too. But
in early 2013, the Fedís extraordinary stock-market levitation fostered by the
implied promise to ramp QE3 whenever stocks faltered started seducing investors
away from gold at a
wildly-unprecedented rate. As gold plummeted in the second quarter of that
year, effectively a once-in-a-century event, investors and speculators
alike fled gold stocks before they stabilized once again.

But in late 2014 and a second
time in mid-2015, the gold stocks suffered subsequent waves of panicked selling
as gold was battered to deeper lows by Fed machinations. American futures
speculators, who are the
dominant driver of goldís price these days with investors largely missing in
action, arrived at the belief that Fed rate hikes were goldís mortal nemesis.
So they aggressively dumped gold in a highly-leveraged way.

That ultimately forced the HGR
down to its recent all-time low of 0.093x in late September 2015.
Never before had the gold-mining industryís stocks been priced so cheap
relative to the price of the metal that overwhelmingly drives their profits!
And these recent new record lows are even more surreal given the fact they
greatly exceed the depths of 2008ís stock panic, the most extreme fear event
weíre likely to see in our lifetimes.

Zoom back out and consider the
extraordinary incongruity of this. Like all markets, the gold stocks are
forever cyclical. They flow and ebb, rising and falling as they gain favor and
lose favor with investors and speculators. Yet essentially since spring 2006,
the gold-mining stocks have been falling on balance relative to gold which
determines their earnings and thus ultimate fundamentally-righteous price
levels.

So for a mind-blowing 9.4
years now, gold stocks have been mostly falling out of favor. Is that normal or
sustainable? Doesnít fear eventually have to peak? Gold mining is a tiny
contrarian sector compared to the broader stock markets, so sooner or later
everyone involved has to hit peak despair. I suspect that very point is
happening this year, which will prove to mark a major reversal to HGR
advances in coming years.

Gold stocks are so devastated
that their value is extreme, and sooner or later here institutional money
managers are going to recognize that and start returning. An industry earning
$200 per ounce at $1100 gold isnít going to zero. And as that inevitable
sentiment shift away from radically-extreme fear happens, the gold stocks are
going to catch a mighty bid. Their upside per their fundamental relationship
with gold is vast.

As of this week, the HUI was
trading at the dismal level of 110. The first time it hit that level in April
2002, gold was at $312. So at this weekís $1085 gold, gold stocks should be
priced radically higher. If they merely rallied enough to restore 2008ís
stock-panic-nadir HGR of 0.207x, the elite major gold miners that dominate the
HUI and GDX ETF would have to soar 104% higher from here! Doubling is nothing
to sneeze at.

If the gold stocks regain
enough favor to just return to their post-panic average HGR of 0.346x, weíre
looking at 241% gains from here in the large gold minersí stocks. And if enough
capital returns to push the HGR back up to pre-panic secular norms of 0.511x,
the HUI and GDX would skyrocket 404% higher! And those headline gains would be
dwarfed by the upside witnessed in the best of the smaller gold miners.

If thatís not enough to
convince someone to take a serious look at deploying capital in gold stocks,
they are simply not interested in buying low and selling high. And incredibly,
this devastated sectorís upside potential based on near-certain HGR mean
reversions is greatly understated. How can that be? As gold itself rebounds
and mean reverts higher, much larger gold-stock rallies will be necessary
for HGR reversions.

2012 was the last normal year
before the radical market distortions spawned by the Fedís QE3 debt-monetization
campaign and its associated jawboning. That year, gold averaged $1669.
Sub-$1100 gold is not normal at all in a surreal economic environment witnessing
the most extreme central-bank money printing in world history! Relatively more
money chasing relatively less gold guarantees higher prices.

But letís be even more
conservative. Between 2010 and 2012, the 3-year span before QE3, the average
gold price was $1490. Letís round that to $1500. Gold returning to $1500 in
the next year or two should be easy considering how extreme and rampant fear and
despair are in it today. Plug in those same well-established HGR targets to
$1500 gold, and the likely upside in this battered sector is far more
impressive.

If the HGR merely returned to
2008ís extreme panic lows, the HUI and GDX upside at $1500 gold rockets up to
182% from here. At that secular post-panic average HGR of 0.346x, the leading
gold stocks would have to soar 371% higher! And finally a full mean reversion
of the HGR to its secular pre-panic average of 0.511x would require a 596%
gold-stock bull market at $1500 gold. Gold stocksí coming potential is
truly unrivaled.

But you certainly donít have
to be this optimistic to deploy capital in gold stocks today while everyone
loathes them. If you merely see a solid probability of a doubling in the coming
year, which is the worst-case mean-reversion scenario, you should be buying up
these epic bargains hand over fist. Where else in these lofty,
overvalued, and
overextended Fed-levitated stock markets is a near-term doubling even possible?

And donít worry about
gold in Fed-rate-hike cycles.
There have been 11 since 1971, and in the 6 that started with gold near major
lows this metal enjoyed stellar average gains of +61.0% over those exact
Fed-rate-hike cycle spans! During the last one between June 2004 and June 2006,
the Fed hiked no fewer than 17 times to blast its federal-funds rate 425 basis
points higher. Gold surged up 49.6% during that!

While gold lost ground in the
other 5 Fed-rate-hike cycles since 1971 as futures speculators universally
believe will happen today, its average loss was just 13.9%. Even more
interesting though, all of these Fed-rate-hike cycles began with gold near
major secular highs. That certainly isnít the case now. Fed rate hikes are
very damaging to lofty stocks and bonds, rekindling gold investment demand for
portfolio diversification.

You can prepare to multiply
your wealth in this long-overdue gold-stock mean reversion higher back up to
fundamentally-reasonable levels relative to gold in a couple ways. The flagship
GDX gold-stock ETF will
beautifully track this sectorís progress. But if you want far bigger gains than
the major miners, the best of the elite fundamentally-superior smaller miners
will see ultimate gains dwarfing those seen in GDX.

Thatís what weíve long
specialized in at Zeal. We are hardcore contrarians whoíve spent the last 16
years studying and trading the markets in order to buy low when few will to
later sell high when few can. Weíve been aggressively buying the best of the
elite gold and silver stocks in recent months, and all those trades are detailed
in our acclaimed weekly and
monthly newsletters for
speculators and investors.

They draw on our decades of
exceptional experience, knowledge, wisdom, and ongoing research to explain
whatís going on in the markets, why, and how to trade them with specific
stocks. They will help you both cultivate an essential contrarian perspective
and multiply your wealth. And with general stocks looking exceedingly toppy,
thatís going to prove incredibly valuable.
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deployed!

The bottom line is gold stocks
have been pummeled down to fundamentally-absurd price levels relative to the
metal which overwhelmingly drives their profits. Investors and speculators have
left this battered sector for dead as they chased the Fedís extraordinary
stock-market levitation of recent years. This has left the gold-mining sector a
wasteland of fear and despair, spawning the fundamental bargains of a lifetime.

Gold stocks are no exception to the ironclad market rule of
endless cyclicality. They canít fall out of favor forever, sooner or later
capital will return to chase these extreme bargains. And the long-overdue mean
reversion higher is going to create great fortunes for the hardened contrarians
smart enough and tough enough to fight the herd and buy these extreme lows.
Gold stocksí vast upside potential is unrivaled in all the markets.